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Which Tax Cuts Should We Extend?

A new report from the Urban-Brookings Tax Policy Center on the tax cuts slated to expire in January — along with a front-page New York Times story on one of them, the payroll tax cut — should lead policymakers to change the way they think about which tax cuts should, or shouldn’t, continue.

Politically speaking, the expiring tax cuts now fall roughly into three categories:

  1. Likely to be extended: policymakers generally agree that we should extend the middle-class tax cuts enacted under President Bush, for example.
  2. In dispute: policymakers strongly disagree over whether to extend the high-income Bush tax cuts (that is, the income, capital gains, and dividend tax cuts for incomes over $250,000 per couple, as well as the cut in the estate tax).
  3. Imagen
  4. Likely to expire: both parties seem content to let the payroll tax cut expire, as the Times story explains.

But in terms of what’s best for the country, the TPC report provides the latest evidence that we should let the high-income tax cuts expire while seriously considering extending the payroll tax cut.

Extending the high-income tax cuts would cost $83 billion in 2013, TPC found, but it would expand the economy by only $40 billion that year, according to Mark Zandi of Moody’s  In other words, the high-income tax cuts provide less than 50 cents of economic boost per dollar of cost.  (See chart.)

As for the payroll tax cut, TPC shows that extending it in 2013 would cost $115 billion, and Mark Zandi estimates that this would boost the economy by $100 billion, which means the payroll tax cut’s economic bang for the buck is nearly twice that of the upper-income tax cuts.

The reason is simple:  the payroll tax cut goes more to working and middle-class people, whose spending rises more in response to increases in their income than does wealthier people’s.

One option would be to phase out the payroll tax cut over a few years rather than let it expire abruptly in January, which would limit the near-term hit to the economy while making clear that the tax cut will indeed be temporary.  Whatever policymakers ultimately decide, the payroll tax cut deserves more careful thought.

Chuck Marr
Vicepresidente de Política Tributaria Federal